$8.5 Billion Deal Near in Suit on Bank Mortgage Debt

Bank of America is completing an agreement to pay $8.5 billion to settle claims by investors that purchased mortgage securities that soured when the housing bubble burst, according to people briefed on the deal. It represents what is likely to be the single biggest settlement tied to the subprime mortgage boom and the subsequent financial crisis of 2008.

The settlement would wipe out all of the company’s earnings in the first half of this year, and it could also provide a template for deals with other big banks that face tens of billions in similar claims.

“I think this is huge,” said Michael Mayo, a bank analyst with Crédit Agricole in New York. “It’s about time the industry resolves issues from the financial crisis and focuses more on righting their companies and improving the economy. This is the most significant step since the financial crisis that helps do that.”

The proposed settlement is with a group of more than 20 investors that include the asset managers Pimco, Metropolitan Life and BlackRock, as well as the Federal Reserve Bank of New York. Together they hold mortgage-backed securities that represent more than $100 billion in home loans from Bank of America, the nation’s biggest bank by assets.

The securities affected by the deal come from Countrywide Financial, the subprime mortgage lender whose practices have come to symbolize the excesses of the housing boom. Bank of America bought Countrywide in 2008.

The settlement goes beyond just the securities owned by these investors, however.

It covers nearly all of $424 billion in mortgages that Countrywide issued, which were then packaged into mortgage bonds. That means that a broader group of investors will share in the proceeds, according to the people who were briefed on the proposed settlement, but were not allowed to speak publicly.

In addition, the deal will require Bank of America to improve its payment collection process by hiring specialists to focus on high-risk loans, and do a better job of tracking whether the bank is adhering to its own internal loan-servicing standards.

The negotiations began last fall but picked up speed in recent weeks as the end of the second quarter approached. For the investors, settling avoids a costly, multi-year legal fight, while Bank of America can clear away one of the biggest clouds hanging over the company.

Bank of America, JPMorgan Chase, Citigroup and Wells Fargo have the greatest exposure to the legal claims that they bundled troubled home loans and sold them as sound investments. Together, they are likely to absorb roughly 40 percent of the industry’s mortgage-related losses.

In a research note, Paul Miller of FBR Capital Markets projected that Bank of America could face a total of $25 billion of losses from the soured mortgages, the most of any of the major banks.

Bank of America has already paid out or set aside about $17 billion. So the settlement would bring the bank’s losses in line with those projections.

Photo

A settlement would be a sharp reverse for Bank of America's chief executive, Brian Moynihan, who had wanted to fight.Credit
Jeff Kowalsky/Bloomberg News

On Wednesday, the bank is expected to announce plans to set aside even more money, in addition to the $8.5 billion. Those funds will be earmarked to cover future losses on mortgage securities as well as other mortgage-related expenses not covered by the deal disclosed Tuesday. Some of that will be offset by one-time revenue gains.

Other big banks face sizable risks, too. Mr. Miller predicted that Chase could expect losses reaching as much as $11.2 billion. Wells Fargo has potential losses of up to $5.2 billion, while Citigroup could see losses top $3.3 billion.

Once it is approved by Bank of America’s board, which met Tuesday, the settlement will require court approval in New York. Bank of America is expected to take a $5 billion after-tax charge in the second quarter to cover the payout.

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While the board has yet to approve the settlement, both sides are aiming to have it done as soon as Wednesday, said the people who were briefed on the deal. If successful, the bank hopes to turn investor attention away from the huge payout and to the bank’s performance in the second half of the year.

Under the terms of the accord, Bank of America would deliver the money to the trustee for the securities, Bank of New York Mellon, which would distribute it to the institutional investors.

The issue of how much Bank of America will have to compensate investors in mortgage securities it assembled has been hanging over the bank’s shares since last fall. But the bank does not anticipate having to raise capital or sell stock to find the money for the settlement.

Still, other huge risks loom from the fallout of the subprime mortgage crisis. All 50 state attorneys general are in the final stages of settling an investigation into abuses by the biggest mortgage servicers, and are pressing the big banks to pay up to $30 billion in fines and penalties.

What’s more, insurance companies that backed many of the soured mortgage-backed securities are also pressing for reimbursement, arguing that the original mortgages were underwritten with false information and did not conform to normal standards.

In an interview on Tuesday, before reports of the Bank of America settlement, Sheila C. Bair, the chairwoman of the Federal Deposit Insurance Corporation, worried that the unresolved mortgage claims continued to hurt the broader economy.

“Unresolved legal claims could serve as a drag on the recovery of the housing market,” Ms. Bair said. “The healing of the housing market is essential to the recovery of the broader economy.”

The huge settlement represents a sharp move away from the position that Bank of America’s chief executive, Brian T. Moynihan, initially adopted last fall when the legal effort by the investors began.

Mr. Moynihan said in October, “We’d love never to talk about this again and put it behind us, but the right answer is to fight for it.”

Not long after that, however, the bank started negotiations with the investor group, led by a Houston lawyer, Kathy Patrick. And in January, it reached a settlement with Fannie Mae and Freddie Mac, the government-controlled housing finance giants, to buy back $2.5 billion in troubled mortgages, settling potential claims from them.

A version of this article appears in print on June 29, 2011, on Page A1 of the New York edition with the headline: $8.5 Billion Deal Said to Be Close In Bank Lawsuit. Order Reprints|Today's Paper|Subscribe